China and the World of Business • China Business and the World

Month: December 2012

Canada has given the “all clear” for the China National Offshore Oil Corporation (CNOOC) to purchase upstream oil and gas developer Nexen, a company with reserves in Canada and the Gulf of Mexico (among other places) and, perhaps more important, some interesting capabilities in shale oil and oil sands. CNOOC’s interest begins with the reserves but the long-term value of Nexen lies in its oil sands capabilities. China has an estimated 14.5 billion barrels of oil locked up in oil sands, a quantity that is over twice the nation’s proven conventional reserves. Even with the technological hurdles, the value of Nexen to China and its energy security would be huge.

One Down…

CNOOC faces one last hurdle: the Committee on Foreign Investment in the United States (CFIUS.) That body has not been particularly kind to Chinese companies of late, and it has come under fire at home for an approval process that is opaque by Washington standards. There are still those in Congress and industry who flatly oppose any Chinese investment in U.S. fossil fuel assets or reserves. What this decision will come down to is how well CNOOC has laid the groundwork.

Regardless of the outcome in Washington, the fact that the purchase of what one senior Canadian executive called a “bit player” in the energy business has caused such a stir is an indicator that despite CNOOC’s groundbreaking efforts to build goodwill in government and industry, China, Inc. has a long way to go before it is viewed in American capitals with anything but suspicion.

More Spadework

The next bit, though, is the hard part. Building support among like-minded oilmen and politicians with bigger fish to fry is easy. Winning over the growing slice of America that believes the worst about China and state-owned enterprises is going to demand more than schmoozing: a wholesale rethink of corporate behavior is in order.

The formula that CNOOC and its fellow Chinese companies will need to follow when pursuing global mergers and acquisitions begins with the company’s actions. How has the company behaved in its operations both in China and abroad? Has it operated in a transparent manner, or has it used its government ownership as a fig-leaf to hide its activities behind a veil of secrecy?

Has the company been fair with its partners? Has it built up a genuinely positive environmental record (one that partners and foreign competitors would agree is world-class?) Does it behave in a high-handed manner, or does it operate with humility? Is it out for long-term cooperation, or does it just want to dismember its acquisitions for a few key personnel, some technology, and its reserves?

Next, the company has to consider its reputaiton. If it is behaving well, does it get credit for its actions across the full scope of its stakeholders, or do too many people fail to discern a difference between CNOOC and other oil companies? For that matter, is it seen as a company, or is it perceived as little more than an extension of the Chinese government? Is it telling its story to enough of the right people to matter? And, by the way, who are the right people?

M&A success for China’s companies abroad – for any perceived interloper, for that matter – rests on cash plus positive corporate behavior plus credit for that good behavior with all audiences. Actions + Reputation + Cash. Anything less leaves a deal dangerously vulnerable.

It will be interesting to see how things progress. CNOOC – and China – have a lot riding on this deal.

Back in February I posted an article here (“The Beginning of the End of Outsourcing“) declaring that the thirty-year trend that had shifted jobs and manufacturing to developing countries had hit its apogee. I focused on the Apple-Foxconn relationship, but the point was not about either company. Rather, it was that this powerful partnership, one that has defined the limits of what is possible with contract manufacturing in a developing economy, was also quietly drawing the high-water mark of the offshoring/outsourcing trend. The pendulum was starting to swing back toward corporate control of manufacturing as a core competency and a return to manufacturing close to markets, rather than at the end of a trans-Pacific supply chain.

Entrepreneurs, Stay Home

Proving once again the value of a subscription to The Atlantic, James Fallows and Charles Fishman deliver a pair of superb features in the December issue that offer some more anecdotal examples to suggest that we may be witnessing the beginning of a tectonic movement in manufacturing. Fallows surveys Foxconn and finds its working conditions much improved but sees in those improvements the subtle signs that China’s traditional comparative advantages are in decline.

He then talks to a group of manufacturing entrepreneurs in San Francisco (of all places) who explain that global supply chains are simply not nimble enough to support many businesses. Offering the example of DODOcase, the guys making some of the most stylish smartphone and tablet cases anywhere, Fallows quotes co-founder Patrick Buckley as saying “To figure out all the things we needed to do, and design the product, and launch, and fulfill orders within one month—that meant that outsourcing to China was not ever a feasible option.”

One month. That’s the speed of business. The founders were quoted nine months from design to fulfillment to work with China. Would it have been cheaper? Maybe. Would it have lost them huge opportunities? Absolutely. Would it have exposed them to early knockoffs, possibly by their own contract manufacturer? Hell yes. And Fallows apparently spoke to several companies in the same predicament as DODOcase.

Made in Louisville

Interesting indeed, but a couple of guys in a loft making semi-custom luggage is a very different animal than a Fortune 500 company.

This is where Fishman steps in, telling the story of the revival of GE’s Appliance Park in Louisville, Kentucky. Five years ago the place was the definition of rust belt, a facility built for six production lines and 16,000 workers that had lost nearly everything to China. Things were so bad that GE tried to sell the division, but nobody would buy. As it turns out, that was a good thing. Today there are four production lines making high-end appliances and components for GE products that used to be made in either China or Mexico. One in particular, the high-tech, low-energy GeoSpring home water heater, became a corporate revelation.

So a funny thing happened to the GeoSpring on the way from the cheap Chinese factory to the expensive Kentucky factory: The material cost went down. The labor required to make it went down. The quality went up. Even the energy efficiency went up.

GE wasn’t just able to hold the retail sticker to the “China price.” It beat that price by nearly 20 percent. The China-made GeoSpring retailed for $1,599. The Louisville-made GeoSpring retails for $1,299.

Time-to-market has also improved, greatly. It used to take five weeks to get the GeoSpring water heaters from the factory to U.S. retailers—four weeks on the boat from China and one week dockside to clear customs. Today, the water heaters—and the dishwashers and refrigerators—move straight from the manufacturing buildings to Appliance Park’s warehouse out back, from which they can be delivered to Lowe’s and Home Depot. Total time from factory to warehouse: 30 minutes.

As it turns out, the factory floor is a core competency. What is more, some things can actually be made better and cheaper in America by U.S. labor, especially if those products are destined for markets nearby. Harry Moser, an MIT-trained engineer quoted in Fishman’s article estimates that as much as a quarter of what is made offshore for the US market could be made more cheaply in the US than overseas. After reading Paul Midler’s excellent Poorly Made in China and going back over my notebooks from my own four years as a factory inspector for a U.S. furniture importer, I am betting that not only is Moser onto something, he may actually be underestimating. The GE case proves something that I and Midler have long suspected – that too many companies have outsourced their production to China because they lack the imagination or intelligence to do anything else.

Whose Factory?

We can’t get carried away here, though. The idea that China is reaching the end of its stint as the world’s factory floor is getting tired, and it is too tempting to see in a few examples a trend of factories re-opening across America. Not only would believing either meme be unrealistic, it would miss what is actually going on. We are witnessing the beginning of two trends, rightsourcing and rightshoring.

Rightsourcing, as its name implies, is the science of deciding whether to make something or buy it. That decision used to be such a simple one that the “build or buy” formula was taught in first year managerial accounting. What we have discovered in the past two decades is that there is more to the decision than just the math, that there are attendant risks and variables that make the formula far more complex. Is somebody going to steal my designs and formulas and sell them to my competition? Can I really trust somebody else to help me avoid quality or labor issues that could hurt my business? Am I pouring away a hidden competitive advantage by getting out of manufacturing?

Rightshoring, by contrast, is the science of deciding where to make something. We used to think that making things in a country where people worked for less money would be cheaper. But that difference is dissipating, and more questions arise. How much is it costing me to keep a transpacific pipeline full? What are the opportunity costs involved in a six- to nine-month product development process? What are the hidden risks in making something six thousand miles away from the customer? And what happens if there is an uprising or the price of oil goes up 5o%?

We are going to hear a lot more about these trends in the coming months, but it is important to emphasize that this does not mean the end of manufacturing in China, or anything close to it. These trends do point to a future where manufacturing begins to seep back into the world’s great companies, and where products are made closer to where they will be consumed. China will still make a lot of stuff, but it will make less stuff for Europe and America and more stuff for China and the rest of Asia.

At the same time, Chinese companies will set up factories closer to their customers. Think Haier in North Carolina, Lenovo in Europe and Brazil, and Great Wall Motors just about anywhere it sells cars. China will remain a hub of manufacturing as long as consumers in China and the rest of Asia are buying products. But the percentage of goods in the American or European shopping baskets that will be marked “Made in China” looks set to decline over time.

I’ll examine what this means for several specific industries in later posts. In the meantime, it would do many of us a lot of good to start reading up on manufacturing and operations management.

Over the last couple of weeks, several people have asked me what the changeover in the Communist Party leadership will mean for international business in China. The short answer is that if I knew, I’d be wealthy. The longer answer is a bit more helpful.

Many years ago I had a mentor and boss who taught me that the parade of personalities and the flow of policies were fun to watch, but that sticking your finger up to feel the political winds would never offer the insight a business requires to make decisions beyond a six month threshold. What you need to understand, she told me, were the fundamental drivers of policy, not the policies themselves.

By fundamental drivers she meant the five or six issues that the nation’s leaders worried about the most, overlaid with the three core goals of the party at any given time. Add to that a general understanding of the climate in the country, and any relatively educated person could at least have a general hunch about a company’s horizons.

For example, I believe the thee core goals of the Party are:

The continuance of Party rule

The social stability of the nation

China’s rise to global economic and political leadership

No rocket science there. Beyond this, though, things get tricker. What are the five things the members of the Politburo Standing Committee worry about when they wakes up at four o’clock in the morning?

Here is my list of the top five.

Controlling corruption without blackening the entire Party in the process

Getting the economy stabilized and on track for continuing growth

Keeping the PLA in line while retaining its political support

Cleaning up the environment without disrupting the economy

Keeping expressions of popular discontent from coalescing into a coherent anti-party front.

These are certainly open for debate, but what all of this suggests is that global companies will be welcome in China to the extent that they address (i.e., demonstrably take into account) these five priorities. What is more, given that domestic attitudes about foreign investment in China have, in the past five years, gone from “generally positive” to “generally ambivalent,” companies are going to find themselves compelled to make a case to their local stakeholders that they have something unique to offer just by being here.

Mind you, I’m not necessarily talking about approvals to do business, although that is an issue. Instead what I mean is that with every audience, from regulators to consumers, every business would do well to remember that being foreign no longer buys you much, and that in the current environment there is no particular priority placed on letting foreign firms into China.

In short, the outlook is not exceptionally good in the near term, but there is as yet little cause to be pessimistic. All of us need to stay tuned.